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Chesapeake 3Q Beats, Falls Y/Y

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Natural gas provider Chesapeake Energy Corp. (CHK - Analyst Report) reported adjusted third quarter 2012 earnings of 10 cents per share, beating the Zacks Consensus Estimate by a penny. However, the reported figure plunged by more than 86% from the year-earlier profit of 72 cents a share. The underperformance came in the wake of a 59.1% decline in average price realizations for natural gas.

Total revenue dropped 25.3% year over year to $2,970.0 million from $3,977.0 million a year ago. However, the top line got the better of the Zacks Consensus Estimate of $1,417.0 million.

Operational Performance

Chesapeake’s average daily production in the quarter increased nearly 24.4% year over year to 4,142 million cubic feet equivalent (MMcfe), of which natural gas accounted for 79%. The percentage of natural gas production to total volume decreased 4% points on an annualized basis. However, natural gas production grew 18.9% to 302 billion cubic feet (Bcf) from 254 Bcf, while oil production expanded 96% from the year-ago level.

Natural gas equivalent realized price in the reported quarter was $4.04 per thousand cubic feet equivalent (Mcfe) versus $5.78 in the year-earlier quarter. Average realizations for natural gas were $1.97 per Mcf compared with $4.82 per Mcf in the year-earlier quarter. Liquids were sold at $90.79 per barrel, up from the year-ago price of $82.47 per barrel.

On the cost front, production expenses decreased 8.7% from the year-earlier level to 84 cents per Mcfe.

Financials

At the end of the quarter, Chesapeake had a cash balance of $142 million. The debt balance stood at $15,755 million, representing a debt-to-capitalization ratio of 47.1% (versus 42.0% in the preceding quarter). Operating cash flow decreased 20.7% year over year to $1,118 million.

The largest U.S. natural gas producer after ExxonMobil Corporation (XOM - Analyst Report), Chesapeake said that it planned to secure a five-year $2 billion loan facility to pay down a $4 billion loan it achieved in May this year as well as other debt costs.

Guidance

As the company shifts its focus to more liquid-rich plays in the last four years, it expects its natural gas production to turn down approximately 7% in 2013, while liquids production is expected to increase approximately 29%. The company also remains well on track to meet its objective of 250,000 barrels per day of net liquids production in 2015.

Management continues to review operational plans for 2013 that could bring changes to Chesapeake’s drilling operation as well as estimated production levels in 2013.

Chesapeake expects 2012 as well as 2013 total production to be in the range of 1,402–1,434 Bcfe and 1,390–1,454 Bcfe, respectively. For 2012, the company had earlier expected to generate volumes in the range of 1,396 – 1,428 Bcfe.

For 2012 and 2013, the liquids production forecast range is 30–31 million barrels/MMBbls (versus prior expectation of 29-30 MMBbls) and 36–38 MMBbls, respectively. Chesapeake expects its natural gas production in the bands of 1,120–1,140 Bcf and 1,030–1,070 Bcf for 2012 and 2013, respectively.

Outlook

We appreciate Chesapeake’s initiative of deploying more funds toward liquids. During this year and the next, it aims to spend approximately 85% and 88%, respectively, of its total drilling and completion capex in liquids-rich plays.

Again, Chesapeake is committed to its plan of reducing its long-term debt through monetizing its assets and cutting lease-hold spending. This monetization initiative is mainly aimed to cope with the mounting debt level as well as to fill the funding gap for its 2012 expenditures after the collapse of natural gas prices. It aims to reduce debt to $9.5 billion by year end.

All these initiatives are expected to boost the company’s total returns. All said, natural gas still accounts for a major share of Chesapeake’s production (79% in the quarter) and, with no near-term respite in weak natural gas fundamentals, we apprehend the company’s results will be vulnerable to fluctuations in these markets. Hence, we believe that the stock will perform in line with the group and maintain our long-term Neutral recommendation.

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